Advantages and Disadvantages of Mutual Funds

The popularity of mutual funds can be attributed to the numerous advantages that they afford investors. To invest prudently, however, do bear in mind that mutual funds—like all other investments—also carry significant disadvantages. 

Advantages of Mutual Funds

These are some of the benefits that come with investing in mutual funds.

  • Diversification—Most financial professionals believe that diversification is one of the best ways to enhance a portfolio's risk-adjusted return.
  • Low minimum investment—Mutual funds make it possible for investors with very little cash to own an undivided interest in a diversified portfolio.
  • Professional management—Mutual funds give investors access to professional managers whose required minimum account size would otherwise put their services out of the reach of many.
  • A wide range of risk and reward trade-offs—Funds are available with risk levels ranging from the very conservative to the highly speculative.
  • Convenience—This is perhaps one of the most important advantages that mutual funds offer. Conveniences can include 24-hour phone or Internet access to account information, check-writing privileges and automatic investment plans that deduct a specified amount each month from the investor's bank account.
  • Inexpensive reallocation—Most mutual funds are part of fund families—a series of funds all issued by the same parent company but with different investment objectives. Most fund families allow their shareholders a reasonable number of opportunities per year to switch their money among the various funds within the family with low or no service charges applied. Because of this, mutual fund investors can often reallocate their portfolios at a substantially lower cost than others who invest directly in the underlying securities.
  • Asset allocation and retirement planning tools—As a service to their shareholders, many mutual fund companies offer free services, such as asset allocation optimization software or retirement planning analyzers, that are designed to help investors select the most appropriate funds for their needs.
  • A wide range of investment styles—With literally thousands of mutual funds in existence and more being created all the time, the odds are good that, no matter what investment vehicle, style or approach you prefer, there is a mutual fund that specializes in that sort of investment.

Disadvantages of Mutual Funds

Despite these many advantages, you are wise to approach any investment in a mutal fund with an awareness of the following drawbacks.

  • Management turnover—Many investors select mutual funds based on their past performance. Unfortunately, with the high rate of management turnover within the asset management industry, the managers who were primarily responsible for a particular fund's superior performance in the past may no longer be working for that company. Therefore, investors should examine not only a fund's past performance, but also who was responsible for that performance and whether the same manager or team is still running the fund.
  • Investment style fluctuations—An investor who wants to maintain a certain asset allocation has to rely on the manager of the fund that he or she selects not to deviate from the fund's stated investment styles. Any changes in priorities or investment styles could override and defeat the investor's asset allocation.
  • Panic selling—During sharp market downturns, many investors have a tendency to panic. When this happens, they look to sell their fund shares. Since the fund managers must redeem the shares, they have no choice but to sell the underlying securities at a time when there are few, if any, buyers. If not for the flood of redemptions, the fund manager would likely not sell the underlying securities. The professional manager's expertise, judgment and objectives can be upset and overridden by the actions of the fund's investors.

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